German Chancellor Angela Merkel speaks at the annual congress of the Federation of German Industry (BDI) on June 20, 2017 in Berlin, Germany.

German Chancellor Angela Merkel said Monday her efforts to form a three-way coalition government had failed, thrusting Germany into a political crisis and pushing Europe's largest economy closer to a possible new election.

The pro-business Free Democrats (FDP) unexpectedly pulled out of more than four weeks of negotiations with Merkel's conservative bloc and the ecologist Greens, citing irreconcilable differences.

The euro hit a two-month low against the yen soon after FDP leader Christian Lindner said on Sunday that his party was withdrawing from the talks as the three would-be partners could not find common ground on key issues.

A tired looking Merkel said she would stay on as acting chancellor and would consult with President Frank-Walter Steinmeier on how to move forward, adding that a deal had been within reach.

"It is a day of deep reflection on how to go forward in Germany," Merkel told reporters. "As chancellor, I will do everything to ensure that this country is well managed in the difficult weeks to come."

It was a sobering moment in the career of a woman who during 12 years in power became a symbol of stability, leading the euro zone during its debt crisis and building compromise within the European Union on a deal with Turkey to stem migrant arrivals.

Merkel was weakened after a September election as voters angry with her decision in 2015 to open Germany's borders to more than a million asylum seekers punished her conservatives by voting for the Alternative for Germany (AfD) far-right party.

The break down of the talks leaves Germany with two unprecedented options in the post-World War Two era: Merkel forms a minority government, or the president calls a new election if no government is formed.

The center-left Social Democrats (SPD), Merkel's current coalition partners who were the second-biggest party in the election, have ruled out a repeat of an alliance with her conservatives, who won the vote but were left with fewer seats.

There is little appetite for a new election. The main parties fear that the AfD would win more than the almost 13 percent of votes it secured to enter parliament for the first time as the third-biggest party.

'Difficult for the economy'

Failure to form a government in Europe's largest economy could have implications for everything from euro zone reforms championed by French President Emmanuel Macron to the shape of relations with Britain after it leaves the EU.

The next government was also expected to increase spending, raising hopes of more fiscal stimulus for an economy that has been relying on consumption and state spending for growth.

While campaigning for a fourth term, Merkel cited the strong performance of an economy that has been growing since 2010 and a record low unemployment rate as reasons for voters to back her conservatives.

Economists have accused her of complacency on the economy, saying she should overhaul the tax system to make it more growth-friendly and boost investment on digital infrastructure — demands also made by the FDP.

The DIHK Chambers of Industry and Commerce said a prolonged period of uncertainty would be bad for the economy.

"There is the danger that work on major issues for the future of our country will be delayed for a prolonged period of time," DIHK President Eric Schweitzer wrote in an email. "German companies must now prepare for a possibly long period of uncertainty. This is always difficult for the economy."

The break down of the talks came as a surprise, especially as it was announced by the resurgent FDP, Merkel's preferred coalition partners who had dropped out of parliament four years ago and had ruled with her conservatives during 2009-2013.

After its impressive electoral comeback, the FDP's decision to pull out of coalition talks was puzzling, according to Jackson Janes, of the American Institute for Contemporary German Studies at Johns Hopkins University.

"And it is also a dangerous game of poker for Germany," Janes added.

Immigration was the main sticking point in the negotiations.

Merkel's Christian Democrats (CDU) and their Christian Social Union (CSU) Bavarian allies had demanded a yearly cap on the number of asylum seekers that Germany accepts each year, a measure rejected by the Greens.

There was also discord over conservative proposals to limit the right of some accepted asylum seekers to bring in immediate family members. Merkel said a compromise with the Greens on immigration had also been possible.

Government spending, tax cuts and climate policy had also been sticking points.

"Today there was no progress but rather there were setbacks because specific compromises were questioned," the FDP's Lindner said. "It is better not to rule than to rule the wrong way. Goodbye!"